01 December 2015

PIIE/Nicolas Veron: EU Endorsement of the IFRS 9 Standard on Financial Instruments Accounting

IFRS 9 was adopted by the IASB in July 2014, following several years of technical work and consultations with stakeholders. The process for the endorsement of IFRS standards and their subsequent integration into EU law gives the European Parliament a specific role of scrutiny.This motivates the consideration by the European Parliament of new IFRS texts, especially significant ones such as IFRS 9. Mr Veron is grateful for the invitation extended by the Economic and Monetary Affairs (ECON) Committee and the opportunity to offer comments in this context.

In view of the current state of development of EU financial regulatory institutions, it is appropriate for the European Parliament to be involved in the IFRS endorsement process. Indeed, Mr Veron is on record for having recommended the rejection by the European Parliament of an IFRS standard whose adoption Mr Veron deemed not in the European public interest.In the case of IFRS 9, however, the balance of arguments is overwhelmingly in favor of endorsement, both on the standard's own merits and with consideration of the wider institutional context. The key corresponding arguments are developed succinctly in the rest of this statement.

IFRS 9 responds to the G-20's call to accounting standard setters, made at the London Summit in April 2009, to move from an incurred-loss to an expected-loss model in accounting for financial instruments.

The world's two main standard setters, namely the IASB and its American counterpart the FASB, have failed to agree on a joint approach to address this challenge and have chosen different definitions of expected loss for financial accounting purposes. This division is unfortunate, since the G-20 had also called repeatedly for the IASB and FASB to converge towards a single set of standards. It is also unsurprising, as the two bodies have few incentives to heed the G-20's call for convergence and have also diverged on other important issues in recent years. Mr Veron agrees with the joint assessment made by experts from Lancaster University for the European Parliament, namely that none of the two approaches appears unambiguously superior to the other at this point, that future practice will help form a more concrete picture of the differences between them in practice, and that the divergence between IASB and FASB does not justify a refusal by the EU to endorse IFRS 9.

In their submissions to the EFRAG as part of the endorsement process, the EBA and the ECB have supported endorsement of IFRS 9 with consideration of the assumed benefits of the expected-loss model for financial stability. The ESMA has similarly supported the standard's endorsement. Experts commissioned by the European Parliament have likewise recommended endorsement of IFRS 9, on grounds both of its expected contribution to financial stability and of its compliance with the criteria set out in the IAS Regulation. Mr Veron concurs with these assessments and the resulting recommendation of endorsement.

Given the particular significance of IFRS 9, the decision on its endorsement will have implications in the broader context of the EU's adoption of IFRS. This discussion relates to the debate on the governance of the IASB and its parent organization the IFRS Foundation, a debate that is as old as the IASB itself. A recurring theme is that the European Union has insufficient influence in IFRS standard-setting.

It is important to keep in mind here that IFRS represents a remarkable case of EU global leadership. Indeed, it is arguably the single most prominent example of the EU successfully leading the way in international financial reform in the past two decades, with its initial adoption of IFRS in 2005 followed by an increasing number of jurisdictions in the ensuing years. There can be little doubt that the IFRS Foundation would have struggled to achieve so much without the initial impetus provided by the EU, whose decision was formed at the political level in 2000 and enshrined in EU legislation in 2002. Against this background, the EU has a stake in the continued success of the IFRS project.

The EU must thus resist the potential temptation to use the process of endorsing individual standards, such as IFRS 9, to make statements or create leverage about the governance of the IFRS Foundation and the EU's role therein. On the contrary, concerns about the integrity and reputation of both the IASB and the EU itself demand that discussions about individual standards be strictly separated from those about the standard-setting organization and its governance and funding arrangements. The heavy-handed pressure exerted by the EU in October 2008 to force the IASB to modify its then standard on financial instruments, IAS 39, in order to suit short-term interests of some European banks, provides a cautionary tale of a questionable practice that has left deep scars and should not be repeated.

The governance of the IFRS Foundation is pioneering and experimental in nature, since no directly relevant precedent exists for this kind of standard-setting function at the global level, even though useful lessons can of course be learned from other experiences. As such, this governance is intrinsically imperfect and can be improved. In particular, a better definition of the Foundation's prevailing global stakeholders, a clearer framework of accountability vis-à-vis these, and a related overhaul of funding arrangements, appear desirable to this observer. One should be under no illusions, however, that a simple fix might comprehensively address most governance concerns directed at the IFRS Foundation. Specifically, the notion of democratic accountability raises difficult questions when envisaged on a global scale, given the heterogeneity of political regimes across the world's jurisdictions, including those that have adopted IFRS or substantially model their standards on them.

The issue of EU influence is separate from that of the IFRS Foundation's governance, in which Europeans are certainly not underrepresented—to give only a few examples, the current chairman of the Foundation's Trustees is French; the chairman of the IASB is Dutch; and its vice chair, while originally from New Zealand, also has a strong European background as former chairman of the UK Accounting Standards Board. To the extent that EU influence over IFRS is an issue, it is related to the fragmentation of mandates over accounting policy among different authorities. The EC has the leading role in IFRS endorsement; national authorities are charged with enforcing IFRS implementation by listed companies; and ESMA fosters cooperation and convergence in this area. By contrast, in most other jurisdictions, these functions are all performed by a single organization, e.g. the Financial Services Agency in Japan or the Securities and Exchange Commission in the United States. Reform of relevant EU arrangements might be usefully considered in the new context created by the Capital Markets Union project.

Mr Veron concludes: "The European Union should endorse IFRS 9 expeditiously. Separately, it should keep engaging with the IASB in the preparation of adequate follow-on adjustments in anticipation of the forthcoming review of insurance accounting.”

Full testimony

© Peter G Peterson Institute for International Economics